Productivity and wages growth remain the key inflection points for interest rates as the Reserve Bank walks a tight rope in trying to tame inflation without strangling the economy.
RBA Governor Philip Lowe in his last appearance before the House of Representatives Standing Committee on Economics on Friday said Australian monetary policy was now in a “calibration phase’’.
The RBA is now watching the economic data “every single month’’ and “I hope’’ making only small adjustments in monetary policy, Dr Lowe said.
But in order to get inflation from its current level of around 6 per cent to the 2-3 per cent target range, RBA would need to see some moderation in unit labour costs in the Australian economy.
Dr Lowe estimates that wages growth of about 4 per cent would be consistent with getting inflation back into its target range.
But that is predicated on productivity growth getting back to pre-pandemic levels.
There is a long way to go on both the unit labour cost and productivity front.
Unit labour costs have risen to 8.3 percent a year compared with 2.5 per cent on average prior to the Covid-19 pandemic.
Some economists remain pessimistic about the likelihood of the productivity rebound assumed by the RBA actually happening.
“While the governor believed inflation could return to the 2-3 per cent target band by 2025, it was predicated on productivity growth increasing,’’ Citi economist Farazz Syed told The Australian. “In the absence of rising productivity growth, the governor noted that inflation and wages would look ‘different’.’’
“We remain bearish on productivity growth and continue to expect two additional rate hikes by the Bank this year, in October and November, for a terminal rate of 4.6 per cent,’’ he said.
NAB’s monthly business survey also provide cause for concern.
It showed that wage rises announced by the Fair Work Commission review in early June had caused a sharp jump in wages and prices after the decision took effect on July 1.
The survey showed labour cost growth jumped to 3.7 per cent in quarterly equivalent terms (14.8 per cent annualised), versus 2.6 per cent in June.
Final price growth jumped to 2 per cent from 1 per cent in quarterly terms.
But the market is backing the Central Bank that these pressures will weaken.
The cash rate futures market believes there is only about a one third chance of another 25-basis point rise this cycle.
Let’s hope that this time the money markets are right.
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